Time Variation in the Covariance between Stock Returns and Consumption Growth

ABSTRACT

The conditional covariance between aggregate stock returns and aggregate consumption growth varies substantially over time.
When stock market wealth is high relative to consumption, both the conditional covariance and correlation are high. This pattern
is consistent with the “composition effect,” where agents' consumption growth is more closely tied to stock returns when stock
wealth is a larger share of total wealth. This variation can be used to test asset‐pricing models in which the price of consumption
risk varies. After accounting for variations in this price, the relation between expected excess stock returns and the conditional
covariance is negative.